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Why a charitable lead trust? With the monthly Internal Revenue Code Section 7520 rates at all-time lows, now is an optimum time for wealthy donors—who want to benefit charity and pass property to family members at little or no gift tax—to create charitable lead trusts. Although there's no income tax charitable deduction for most lead trusts (drafted so that the donor isn’t taxable on the lead payments to the charity), the gift to the family members who will receive the trust assets at the end of the charity’s interest can be structured so that there's considered to be no gift or a small gift for tax purposes.
When the charity is a private foundation, care must be taken that the donor’s involvement in the foundation doesn’t result in the value of the trust’s assets at the donor’s death being includable in his gross estate. You’ll see what the donor did to avoid that result in this letter ruling.
Situation. The lead-interest beneficiary of the donor's charitable lead annuity trust (CLAT) is a private foundation. Number One Son (star of an old Charlie Chan movie?) is the sole trustee. The donor and his spouse are the foundation’s founders. The donor, his spouse, Number One Son and Number Two Son are the foundation’s directors.
If the foundation ceases to exist or is not described in each of IRC Sections 170(b)(1)(A), 170(c), 2055(a) and 2522(a) during the annuity period, the trustee is to distribute the annuity amount to one or more qualified organizations having a similar purpose and in equal or unequal shares among them, as the trustee chooses. The CLAT also provides that Donor shall never exercise the just-described powers of the trustee. No portion of the annuity amount may be prepaid or commuted by the trustee.
At the expiration of the annuity period, the trustee is to distribute the remaining trust assets in equal shares to the trustees of trusts established for Sons One, Two, and Three.
On or immediately before any valuation of trust assets, the trustee is to report to the “valuation trustee” the identity of all assets of the CLAT that do not have a readily ascertainable fair market value. The valuation trustee is to have any of those assets valued as of the appropriate valuation date and report the value to the trustee. The valuation is to be made independent of the trustee and of any related or subordinate party or disqualified person with respect to the CLAT. The valuation trustee and any successor must always be independent—any party other than a related or subordinate party with respect to the CLAT.
The CLAT provides that if the trustee fails or ceases to serve as the trustee for any reason, then Son One has the power to appoint any individual(s) (including, without limitation, himself, but specifically excluding Donor and Spouse), any corporate trustee or both to serve as sole trustee or co-trustees. If Son One cannot exercise this power, Son Two acquires it. If Son Two cannot exercise this power, Son Three acquires it. Neither the donor nor his spouse shall ever serve as a trustee or hold or exercise any powers of the trustee.
The board of directors of the foundation amended the foundation's bylaw to provide that if, at any time, the foundation is a beneficiary of a charitable lead trust, a charitable remainder trust or other similar trust, and the charitable trust was established by a director or officer of, or substantial contributor to, the foundation, the director, officer or substantial contributor establishing the charitable trust shall be prohibited from acting on or being involved in matters concerning the receipt, investment, grant or distribution of, or any other decisions involving, funds received by Foundation from the charitable trust. In addition, any funds received from a charitable trust shall be segregated into a separately established and dedicated account and separately accounted for on the records of the foundation to clearly allow the tracing of the funds into and out of the separate account.
A director who establishes a charitable trust for the benefit of the foundation may not be counted when establishing a quorum to vote on matters relating to the receipt, investment, grant or distribution of, or any other decisions involving, funds received by Foundation.
No committee established by the board of directors, including a standing committee, shall include as a member a director or officer of, or a substantial contributor to, any foundation who has established a charitable trust of which the foundation is a beneficiary.
The Internal Revenue Service rules:
• The funding of the CLAT will be a completed gift for federal gift tax purposes;
• The donor is entitled to a gift tax charitable deduction under IRC Section 2522 based on the present value of the annuity, determined under Reg. Section 25.2512-5; and
• On the donor’s death, no portion of the principal of the CLAT will be included in the donor’s gross estate under IRC Sections 2033, 2035, 2036 or 2038. Letter Ruling 201323007.
P.S. For CLATs, be mindful of the generation-skipping tax rules.
© Conrad Teitell 2013. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.